Question

Vandalay Industries is considering the purchase of a new machine for the production of latex. Machine A costs $2,900,000 and will last for six years. Variable costs are 35% of sales and fixed costs are $170,000 per year. Machine B costs $5,100,000 and will last for nine years. Variable costs for this machine are 30% of sales and fixed costs are $130,000 per year. The sales for each machine will be $10 million per year. The required return is 10% and the tax rate is 35%. Both machines will be depreciated straight-line over their lifetimes. a.What are the equivalent annual costs of each machine?b. Which machine should Vandalay Industries select?

Answer 1

Data
	Machine A	Machine B
Purcahse cost	29,00,000.00	51,00,000.00
Life	6.00	9.00
Variable cost	35% of sales	30% of sales
Fixed cost	1,70,000.00	1,30,000.00
Sales value per year	1,00,00,000.00	1,00,00,000.00
rate of return	10%	10%
Tax rate %	35.00	35.00
Machine A
	Equation
Variable cost	Sale x 35%	35,00,000.00
Fixed cost		1,70,000.00
Total cost per year		36,70,000.00
Add: Initial cost		29,00,000.00
TOTAL		65,70,000.00
PVAF, 10%, 6 years	From annuity table	4.3552
EAC	6570000/4.3552	15,08,541.51
Machine A
Variable cost	Sale x 30%	30,00,000.00
Fixed cost		1,30,000.00
Total cost per year		31,30,000.00
Add: Initial cost		51,00,000.00
TOTAL		82,30,000.00
PVAF, 10%, 9 years	From annuity table	5.759
EAC	8230000/4.3552	14,29,067.55
Based on Equalent annual cost method, project B should be selected being less EAC